Last Updated on Nov 4, 2022 by Aradhana Gotur
In addition to evaluating a company’s financial statements, analysing the industry in which it operates helps decide whether a stock is worth buying. It becomes a basis for forecasting the company’s performance and gauging the value of the stock. In this article, we discuss how to do industry analysis in fundamental analysis.
Table of Contents
What is an industry?
An industry is a combination of companies engaged in similar kinds of business activities. Industries can be present in various categories like construction, manufacturing, light, heavy, durable, non-durable, domestic, and foreign among others. Based on this, automobile companies can be engaged in manufacturing, heavy and light vehicles, and other categories.
What is industry analysis?
Industry analysis means assessing a market/industry to understand its competitive dynamics. It helps investors understand a company’s position compared to its peers. It helps gauge the overall attractiveness of the industry and the factors that determine a company’s success.
Industry analysis tells what is happening in an industry in terms of demand-supply, competition within the industry and with other industries, prospects considering technological changes, and the influence of macroeconomic factors. All in all, it helps identify opportunities and threats for a company in the current scenario and future.
This, in turn, gives you cues as to how well a company is positioned compared to its peers now.
Types of industry analysis
There are three common types of industry analysis:
- Porter’s Five Forces Analysis (Competitive Forces Model)
- Broad Factors Analysis (PEST Analysis)
- SWOT Analysis
1. Porter’s Five Forces Analysis (Competitive Forces Model)
This is one of the most famous models developed for industry analysis. It was introduced by Michael Porter in his book “Competitive Strategy: Techniques for Analyzing Industries and Competitors” in 1980.
According to Porter, there are five forces that help in doing accurate industry analysis. They are as follows:
a. The level of competition in the industry
Intense competition in an industry forces companies to battle against each other to gain dominance. Competitive battles can take the form of anything from price wars to new products and advertising campaigns or an expanded product portfolio. Additionally, government restrictions, labour union norms, and a lack of product/service differentiation also tend to intensify competition among the companies. Together, these reduce the profit potential of the company in the industry.
b. Threat of substitutes of products or services
Most companies in an industry compete with each other as they produce substitute products. Such substitutes limit the earning potential of the company when the industry imposes a ceiling on the prices. Substitution can be fought by product differentiation.
c. Bargaining power of buyers
In an industry with more competitors and a single buyer constituting a large share of the market sales, the bargaining power lies with customers. They are in a position to negotiate lower prices for better quality or ask for additional discounts. This can impact the prices of products and services significantly.
d. Bargaining power of suppliers
A company enjoys bargaining power if the industry has only a few sellers/suppliers. If there are more suppliers, they have the bargaining power and can quote prices, quality, and discounts according to their needs.
For instance, the aviation industry has only two significant aeroplane manufacturers—Airbus and Boeing. Thus, the bargaining power of suppliers in the aviation industry is very high, and the companies can’t do much to negotiate favourable terms for themselves.
e. Barriers to entry
This indicates the ease of entry into the industry. If it is easy to enter the industry, companies constantly face the risk of new competitors. As more companies enter, the availability of substitute products limits the scope of increasing prices. If the entry is difficult, the company with a competitive advantage enjoys the benefits for a longer period.
For instance, entry barriers in the aviation industry are high, given it is an asset-heavy space and is subject to immense legal and regulatory requirements. Therefore, any company that enjoys a competitive advantage stand to benefit for a longer period of time in this industry. Some of the listed aviation stocks are Vistara, Indigo, GoAir, Spicejet, and Air India.
2. Broad Factors Analysis (PEST Analysis)
Commonly called the PEST Analysis, this type of industry analysis evaluates the impact of Political, Economic, Social and Technological factors on an industry. PEST analysis helps analyse the macro environment in which the industry operates.
- Political factors include government policies and regulations relating to taxes, tariffs, environment, labour laws, trade, ease of doing business, and overall political stability. Unfavourable policies can adversely impact a company’s business. For instance, the increase in windfall taxes on oil companies will most likely reduce their profits.
- Economic factors include inflation, interest rates, exchange rates, GDP growth rates, capital market conditions, etc. In case the capital market conditions are not good, companies may find difficulty in raising finance for their operations. This could hamper their growth.
- Social factors are the trends in society, like demographics, population growth, and behaviour in terms of health and fashion, etc. The young population in any area is bound to get older in a few years. If a company is catering to the younger generation now, it will have to offer products for older generations in a few years to stay relevant. If not, it will be forced to shut shop and relocate elsewhere.
- Technological factors are the developments that change the way a company operates and the way of living life. For example, the advent of the internet. A washing machine company cannot survive if it doesn’t offer innovative products and keep up with rivals in technologically-advanced times.
3. SWOT analysis
SWOT stands for Strengths, Weaknesses, Opportunities, and Threats. SWOT analysis helps summarise various industry forces and determine their impact on the company.
Importance of industry analysis
- Industry analysis helps an investor understand the market factors that tend to impact the company in question. These factors can be the industry’s demand-supply forces, demographics, competitiveness, entry and exit costs, and so on.
- Industrial analysis also helps understand if the industry has reached the saturation point or if there is growth potential. If there’s no growth in the industry, the company can also become saturated unless it ventures into newer sub-industries.
- You can compare a company with its peers to understand how it is performing versus them. Do this by comparing financial ratios and other key metrics of the stock in question with the industry average (the average of all companies in the industry/competitors). You can find such data about a company on the respective Stock Page on Tickertape.
How to do industry analysis?
- Review information about the industry: You can find white papers, reports, analyses, research reports, and presentations about the industry online and offline. Read these materials to get to know the industry.
- Dissect the industry: Some industries like the real estate industry, can be huge, and have sub-industries like residential properties, commercial properties, hotels, etc. So identifying the right sub-industry is key to accurate analysis.
- Forecast the potential of the company’s growth: Try to gauge what the future demand and supply in the industry look like. Additionally, assess the health of each company based on its growth rate and product portfolio of the last 5 yrs. Then compare it with peers. You would come to know where the company stands versus its rivals. You can get this information on Tickertape’s Stock Pages.
- Note the recent developments: Make a note of the recent developments within the industry and how they have impacted or may impact the constituent companies presently and in the future.
Industry analysis example
Following is a quick analysis of the defence manufacturing industry in India.
Defence manufacturing industry overview
India is one of the strongest military forces in the world. Over the last 5 yrs, it has been the top importer of defence equipment to gain technological advantages over rival countries.
Defence manufacturing companies/stocks
Bharat Electronics Ltd, Bharat Earth Movers Ltd, and Hindustan Aeronautics Ltd are a few major defence manufacturing companies in India.
Market size of the defence manufacturing industry
In terms of firepower, the Indian defence sector ranks fourth with a score of 0.0979 (0.0 is the perfect score). The government has set the target for defence production at US $25 bn by 2025. Of this, exports account for US $5 bn.
India is one of the world’s biggest spenders in defence. In 2022, our total outlay was Rs. 5.25 lakh cr. (US $66 bn), accounting for 13.31% of the total budget. This surpassed the budget estimates for the fiscal by Rs. 46,970 cr. (US $5.9 bn). Until August 2022, defence exports stood at Rs. 1,381 cr. (US $173.32 mn) in FY 2022-23.
Government initiatives to support the defence manufacturing industry
- The government has taken several initiatives, such as ‘Make In India’, to modernise our armed forces and reduce dependence on imports for defence procurement.
- The Indian government changed the FDI limits in September 2020 to increase defence manufacturing and make India a reliable weapon supplier to friendly countries. The limits are:
- For New licensees, FDI up to 74% is allowed through the automatic route; FDI beyond 74% would have to go through the government route.
- For existing licensees, infusion of new foreign investments up to 49% can be made by declaring change/transfer within 30 days.
- Ministry of Defence has been allocated Rs. 5,25,166 cr. (US $67.66 bn). These funds can be spent on salaries of armed forces and civilians, modernisation of armed forces, pensions, production establishments, maintenance, and R&D organisations.
- 1391 Intellectual Property Rights (IPRs) have been granted by the Indian Patent office until 31st May 2022 under Mission Raksha Gyan Shakti. Indigenously developed Laser-Guided Anti-Tank Guided Missiles were successfully test-fired by DRDO from Main Battle Tank Arjun.
- The Ministry of Defence has earmarked 25% of domestic capital procurement, amounting to Rs. 21,149.47 cr. (US $2.72 bn) in FY 2022-23 to promote private players in the sector.
- As per the Department of Defence Production, 68 AI projects in defence have been planned up to March 2024. Of these, 40 are already completed as on 30th April 2022.
- Defence Acquisition Council (DAC) boosted the ‘Make in India’ initiative in November 2021 to meet the operational needs and modernisation of armed forces.
- In October 2021, Prime Minister Narendra Modi dedicated the seven defence public sector undertakings (PSUs) to enhance efficiency, functional autonomy, innovation and growth potential in the defence sector.
Recent developments in the defence manufacturing sector
- In June 2022, the Ministry of Defence approved military equipment and platforms procurement worth Rs. 76,390 cr. (US $9.84 bn) from domestic industries.
- From April 2000 to March 2022, Foreign Direct Investment (FDI) in the defence sector stood at US $12.51 mn as per the Department for Promotion of Industry and Internal Trade (DPIIT).
- India and Japan have agreed to enhance bilateral security and defence cooperation in May 2022.
- The Startup Incubation and Innovation Centre of IIT-Kanpur signed an MoU with Defence Innovation Organisation to support start-ups and SMEs in the defence sector through iDEX Prime, its flagship programme.
- Bharat Electronics Limited (BEL) and Hindustan Aeronautics Limited (HAL), as a part of the Make in India initiative, signed a contract to co-develop and co-produce the Long Range Dual Band Infra-Red Search and Track System for the Su-30 MKI under the MAKE-II procedure of Defence Acquisition Procedure (DAP) 2020.
Prospects of the defence manufacturing sector
- Increasing joint agreements and foreign mutual trade would strengthen defence ties and offer potential growth opportunities to boost the sector.
- The Indian defence manufacturing industry has huge growth potential due to the rising concerns of national security. Ongoing territorial disputes between neighbouring countries like Pakistan and China have increased the demand for defence equipment in India.
- The Defence Ministry aims to be 70% self-reliant in weaponry by 2027. This has created huge prospects for companies within the industry. Additionally, the government’s emphasis on achieving our goal of “Atmanirbhar Bharat” has further strengthened the prospects of the Indian defence manufacturing sector.
Challenges faced by the defence manufacturing sector
- Despite promoting ease of doing business in India, the time taken and the number of clearances needed to start a defence manufacturing unit is below global standards.
- Imported defence goods don’t involve technology transfer. This results in a degree of reliance on imported goods and deters domestic manufacturing.
- Some manufacturers compromise quality to reduce cost, so their goods don’t meet international standards. This reduces their export potential.
- Despite the budgetary allocation for defence, delayed disbursals result in unspent funds. Therefore, allocated funds are not optimally utilised.
Conclusions of India’s defence manufacturing industry analysis
Considering the various facets of the defence manufacturing industry in India, it is easy to conclude that the government has announced several measures to reduce defence imports and make India self-reliant. With ample impetus, availability of funds, and technological capabilities, defence manufacturing companies can also be positioned to export the produce.
Conclusion
Like most types of analysis, industry analysis is subjective and involves estimations. Incorrect interpretation of data can lead to wrong conclusions. So it is important to be mindful when collecting data and drawing conclusions.
FAQs
What is industry analysis?
Industry analysis means evaluating a market/industry to understand its competitive dynamics. It helps understand the overall attractiveness of an industry and the factors that determine a constituent company’s success. Industry analysis also helps you understand how a company is performing versus the industrial average.
What are the types of industry analysis?
There are three common types of industry analysis:
1. Porter’s Five Forces Analysis (Competitive Forces Model)
2. Broad Factors Analysis (PEST Analysis)
3. SWOT Analysis
What are the five forces of industry analysis?
According to Porter, there are five forces of industry analysis:
1. The level of competition in the industry
2. Threat of substitutes of products or services
3. Bargaining power of buyers
4. Bargaining power of suppliers
5. Barriers to entry
- How To Analyse Stocks: Identifying Fundamentally Strong Companies - Nov 20, 2024
- Best ETFs in India: NSE ETF Lists of Gold, Debt & Equity ETFs (2024) - Nov 7, 2024
- Best Gold ETFs in India With Expense Ratio - Oct 29, 2024
